Log Market - May

Introduction

The downturn in the export log market gained momentum in May with NZ$ at-wharf-gate prices plunging $12-$17/JAS m³ for unpruned grades and pruned dropping on average $10. Domestic pruned was strongly sought after and had an average price gain of $4/tonne. Domestic unpruned log prices fell marginally ($2/tonne on average) and domestic pulp log price was steady. This market drop has been tough for forest owners, contractors and service providers, especially those with short duration programmes that get heavily affected by prices prevailing over just a few months. This downturn is also unnervingly close to the prior downturn just 10 months ago making decision-making much more challenging with the high market volatility.

Export Log Market

The main driver behind the big price drop was A-grade CFR price dropping to as low as US$95/JAS m³. Other price drivers had marginal impact and offset each other; foreign exchange (marginally unfavourable) and ocean freight (marginally favourable). The large drop in CFR price was a result of log inventory building to over 4.2 million m³ in early April representing over two months' supply. Historically at this level, CFR pricing is vulnerable and volatile.

Ocean freight rates have eased slightly over the past month. The Affinity Daily Market Report's Baltic Handysize Dry Index peaked at 393 at the end of March 2015 and has steadily dropped to 326 as at mid-May (a drop of 17%). However, during the same period, bunkers (fuel oil for ships) rallied from a BWI (BunkerWorld Index) low of 780 (at the end of March 2015 to 900 in mid-May (an increase of 13%). These drivers, whilst largely offsetting each other, resulted in the slight easing of ocean freight rates and some shippers are reporting sub USD$20 for single port load/discharge. These are historically low ocean freight rates for logs from New Zealand.

Log demand in China has been steadily increasing since the Chinese Lunar New Year holiday in February and in response to government initiatives aimed at stimulating a soft housing market. However, large volume inflows have exceeded demand and resulted in the accumulation of inventory at the Chinese ports.

The situation, however, reversed during April as log offtake (sales from ports to traders and processors) increased and aggregate supply dropped slightly. In the chart below, for the month of April, deliveries (imports) were at an average level of 62,000 m³ per day and offtake was at 69,000 m³, resulting in an average daily stock reduction of 9,000 m³ or 261,000 m³ for the month. Looking more into the detail shows that most of the increase in offtake occurred in the second two weeks of April during which offtake averaged 71,500 m³ per day. If this trend continues, it is expected that the market will stabilise and CFR price will firm.

It should be noted that the figures above do not include the over-land export of logs from Russia to China which appear to account for some 90% (or 10.8m m³) of the 12 million m³ annual log trade. The coastal seaports monitored below appear to take the balance of 10%, or about 1.2 million m³. The challenge with this supply chain, however, is that the Chinese/Russia border is many thousands of km from most of the demand for wood products in the big-growth coastal super-cities.

It should be noted that there is a big difference between the current market low-point and that experienced in July of last year. The difference is the CFR price. In July of last year, the CFR price of A-grade logs troughed at US$120/JAS m³. In contrast, the recent low was US$95/JAS m³. At this price logs are both much more competitively priced in China, and much less attractive to alternative supply sources (both domestic and export). This is borne out by reduced supply from North America recently. The low log price is also affecting Russian supply but this is being offset by a much depreciated ruble which is propping up domestic receipts, potentially stimulating supply. As mentioned last month in this report and explored in more detail below, there is considerable speculation regarding the extent of the supply response from Russia and its potential gain in market share at the expense of logs from New Zealand.

How Strong Will the Supply Response be From Russia?

The Russian wood products supply situation is somewhat of an enigma. Russia has the largest potentially harvestable area of forests in the world, estimated at 20% of the world's softwood forests. The total growing stock of Russian forests is estimated at 82.1 billion m³. Annual harvesting levels are around 200 million m³ with exports of only 20 million m³, made up of logs (about 12 million m³) and lumber (about 8 million m³). Most of the exports go to China. The balance is domestic consumption. With 3,600 km of border with China and a greatly depreciated currency (ruble), won't Russia vastly increase its exports of logs and lumber to China? Not necessarily. The following points are salient and suggest only a modest and gradual supply response from Russia.

There are only two over-land import locations in China's north. Both involve vast over-land transport distances both within Russia from forest source and then within China to end-use markets.

The coastal route to market from Russia only carries a small percentage of the total trade and again requires vast inland transport distances to port, then additional shipping costs.

Forest roads, harvesting resources and transportation infrastructure is drastically lacking. Investment in plant and machinery is expensive with the low ruble.

Access to capital is limited, and interest rates are high in Russia.

Most of the investment has been in north-west Russia, a long way from China.

Lumber exports are limited by sawmill capacity but there are few examples of well-conceived and well-executed projects to date.

The Russian government increased stumpage rates and railway tariffs in 2015 – this was presumably a measure to boost ailing government revenues.

Russian logs being received in Manzhouli, northern China. Due to different rail gauges, the logs must be unloaded from Russian wagons and loaded onto Chinese rail wagons. We were told the different gauges were to make military invasion more difficult. In any case, logs imported via this gateway, and surplus to the limited local market, face a 2,000 km train ride to Beijing and much further to other large Chinese cities. One response has been to increase processing of wood products at Manzhouli.

For those that ponder why so much of this Log Report is devoted to covering China, it's because China now takes nearly 80% of New Zealand's export logs (Korea about 13%; India about 5% and Japan only about 2%). Whilst not a great market diversification story, it's the reality of where the demand is, and who is prepared to pay the best prices.

For most forest owners the immediate question on their mind is: where is the market going in the near future? Whilst one can never be certain, indications are that we should see a price rebound in June, and hopefully beyond:

CFR prices have reportedly lifted during May.

Log stocks are in a downward trend.

Exchange and ocean freight rates have moved favourably (slightly).

The Chinese government is committed to continue to implement measures to restore confidence in the housing market and recent indications are that the market is recovering.

The low CFR prices will reduce supply of wood products from other sources.

Russia's supply response is likely to be slow due to massive transportation, capacity and capital formation constraints. The ruble appears to have troughed and is in an appreciating trend.China has announced retiring of large tracts of forest to improve environmental outcomes. This will constrain domestic supply of logs.

Whilst the growth rate in China has fallen to around 7%, consumption has risen to account for more than 50% of GDP (up from 35% in 2009). This is an important transition for China from investment/capital based growth to consumption/services based growth.

Domestic Log Market

Domestic pruned logs are well sought after and top dollar is being paid for reliable, high-quality supply. On average prices for P40/P1 logs lifted $7/tonne in May to $169/tonne. Unpruned prices were down marginally (an average of $2/tonne) due more to softening in the export market than any change in the domestic market dynamics. Domestic pulp log demand and prices were steady.

The Christchurch rebuild is continuing to create strong demand for structural timber in particular, and wood products in general. The booming Auckland housing market is also stimulating additional house construction and adding to the demand for wood products.

Residential dwelling approvals in Australia continued to rise in February 2015, with a 10.6% increase in free-standing dwellings compared with February 2014. Approvals for apartments (four or more storeys) leaped by 17.8%. The 6% depreciation of the NZ$ against the AU$ since the peak of NZ$0.99/AU$ in April will boost returns for exporters of wood products to Australia.

Housing starts in the USA were lack-lustre with March's seasonally adjusted figure of 926,000 well below the expectation of over 1 million. Improving economic conditions, job growth and low mortgage rates, however, are still expected to lead to stronger house construction and demand for wood products.

The PF Olsen log price index fell five points from $100 last month to $95 this month. It is now $10 higher than its cyclical low of $85 in November 2011 and $11 below the two-year average and $6 below the five-year average.

Whilst the export log prices are almost as low as levels they got to in the last market trough in July of last year, the index is faring better by $8 due to the relatively higher price of pruned logs. Forest owners who are harvesting good quality pruned logs with market access are consequently weathering this down-turn better than those heavily exposed to the export log market. A greater focus on domestic supply opportunities, where possible, is also helping to prop up forest owner returns in a very challenging market.

PF Olsen Log Price Index - May 2015

Basis of Index: This Index is based on prices in the table below weighted in proportions that represent a broad average of log grades produced from a typical pruned forest with a mix of domestic/export log supply.

Indicative Average Current Log Prices

Log Grade

$/tonne at mill

$/JAS m³ at wharf gate

Pruned (P40)

169

157

Structural (S30)

105

Structural (S20)

94

Export A

92

Export K

85

Export KI

80

Pulp

50

Note: Actual prices will vary according to regional supply/demand balances, varying cost structures and grade variation. These prices should be used as a guide only.